Key points

But consumers are spending more on cars, home improvements and furnishings, and eating out

As a 15 per cent surge in online retail sales in the twelve months to September adds to department stores’ woes, the Christmas shopping season looks like being far from cheery for the sector

Targeting discount chains and home-improvement specialists seems a better way to profit from a resurgent American consumer than department stores

US consumer spending climbed 3.21 per cent year-on-year in the third quarter of 2015. Rising house prices, a buoyant jobs market, real wage growth and a boost from cheaper oil prices are encouraging consumers to loosen their purse strings. Americans are spending on cars, home improvements and furnishings, and eating out. But clothing sales – a key driver of many department stores’ revenues – have fallen as a proportion of total spending.

Department store woes

A relatively warm summer and disappointing tourist numbers – battered by a stronger dollar and slowing economic growth in Asia – have hit sales and share prices at Macy’s, Nordstrom and other leading department stores. For instance, Macy’s sales contracted for the third consecutive quarter, with a 3.92 per cent fall between July and September year-on-year. Meanwhile, quarterly growth at the more upmarket Nordstrom chain fell to 0.92 per cent in the third quarter, a marked deterioration from 4.92 per cent growth the company enjoyed in the previous three months. Surging online sales are adding to these stores’ woes. In September, 7.4 per cent of retail sales were made online, up 15 per cent in twelve months.

Fighting back

So how can Macy’s, Nordstrom and other department stores fight back? Many have realised they need to adapt to survive and so they are finally investing more in their online businesses. But internet sales represent a relatively small component of their total sales and are likely to remain so for some time.

So department stores are developing fresh tactics to tempt a younger clientele into their shops. With nearly 27 million US teenagers spending $2593 billion (£171 billion) annually capturing this segment of the market is crucial.

Macy’s, for example, has invested $400m in an area at its flagship New York store designed to appeal to consumers between the ages of 13 and 22.The space includes a blow-out bar (for hair) and smartphone-charging stations.

Relentless rise of the discounters

Despite the pummelling taken by many department stores’ shares in 2015, we expect sentiment towards the sector to remain poor for some time given that there are no quick fixes. However, the price weakness could conceivably tempt ‘activist’ investors to acquire stakes in some companies to encourage them to spin off lucrative real estate assets.

Given the trends outlined above, targeting discount chains and home- improvement specialists – which are growing strongly– is a less-risky approach for those seeking to profit from the resurgence in consumer spending.

1 Source: US Bureau of Economic Analysis, October 2015

2 Source: Deutsche Bank Markets Research, 17 November 2015

3 Source: Statistic Brain Research Institute, 24 November 2015

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Prior to joining Aviva Investors, Richard worked for Punter Southall & Co in an actuarial internship role. Richard holds a Masters in Chemistry from the University of Oxford and the Investment Management Certificate.